Performance Measures & Reporting

Accurate performance measurement is essential for evaluating investment results and comparing managers. Understanding various performance metrics and reporting standards is critical for investment advisers.

Return Calculations

Total Return

Total return captures all sources of investment gain:

Total Return = (Ending Value - Beginning Value + Income) / Beginning Value

Example: An investment of $10,000 grows to $11,000 and pays $200 in dividends:

• Total Return = ($11,000 - $10,000 + $200) / $10,000 = 12%

Annualized Return

Converts returns to an annual equivalent for comparison:

Annualized Return = (1 + Total Return)^(1/Years) - 1

Example: A 33.1% return over 3 years:

• Annualized = (1.331)^(1/3) - 1 = 10% per year

Time-Weighted Return (TWR)

TWR eliminates the impact of cash flows to measure pure investment performance:

How It Works: Links sub-period returns before and after each cash flow

Money-Weighted Return (MWR / IRR)

MWR reflects the investor's actual experience, including the timing of cash flows:

On the Exam: TWR is for comparing managers (GIPS requirement). MWR shows the investor's actual experience and is affected by the timing of their contributions and withdrawals.

Risk-Adjusted Performance Measures

Sharpe Ratio

Measures excess return per unit of total risk (standard deviation):

Sharpe Ratio = (Portfolio Return - Risk-Free Rate) / Standard Deviation

Treynor Ratio

Measures excess return per unit of systematic risk (beta):

Treynor Ratio = (Portfolio Return - Risk-Free Rate) / Beta

Jensen's Alpha

Measures the excess return above what CAPM predicts:

Alpha = Actual Return - [Risk-Free Rate + Beta × (Market Return - Risk-Free Rate)]

Example: If CAPM predicts a 10% return but the portfolio earned 12%, alpha = 2%

Information Ratio

Measures the consistency of outperformance relative to a benchmark:

Information Ratio = Active Return / Tracking Error

Where:

• Active Return = Portfolio Return - Benchmark Return
• Tracking Error = Standard deviation of active returns

Comparison of Measures

Benchmarking

Benchmark Selection Criteria

An appropriate benchmark should be:

Common Benchmarks

Global Investment Performance Standards (GIPS)

GIPS are voluntary ethical standards for investment performance presentation, created by CFA Institute.

Objectives of GIPS

1. Promote investor confidence
2. Ensure accurate and consistent performance data
3. Establish a global standard for comparison
4. Promote fair competition among firms
5. Encourage industry self-regulation

Who Can Claim GIPS Compliance

Key GIPS Requirements

GIPS Composite Requirements

All fee-paying discretionary portfolios must be included in at least one composite based on:

• Similar investment strategy
• Similar risk/return objectives
• Comparable mandates

On the Exam: GIPS is voluntary, requires time-weighted returns, and all discretionary fee-paying accounts must be in composites. No "cherry-picking" of best performers.

Key Takeaways

1. TWR measures manager performance (GIPS required); MWR measures investor experience
2. Sharpe uses total risk (std dev); Treynor uses systematic risk (beta)
3. Positive Jensen's alpha means outperformance vs. CAPM prediction
4. GIPS are voluntary standards requiring TWR and composite presentation
5. Benchmarks must be investable, measurable, appropriate, and specified in advance